The role of liquidity in financial markets

Economic or financial crises unavoidably occur and adversely affect economics from time to time. During or post a major financial crisis, market liquidity usually becomes a major source of risk and it needs to be properly studied. This proposal focuses on developing a simple, yet robust and unified theory which models liquidity and its impact on option prices under various market conditions. Through both empirical and theoretical explorations, the newly developed framework will facilitate the explicit quantification and measurement of liquidity risk as well as its impact on the options markets. Furthermore it will assist market regulators in the management of illiquidity and detection of market manipulation.